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Why is a Shareholders’ Agreement Important for Your Business?

Updated October 10, 2024.

When starting or operating a business, many legal decisions need to be made. One of the most crucial for any business with multiple owners is creating an agreement and charging the owners to address the governance, control, and continuation of the business. The form of agreement for corporations is called a shareholders’ agreement or sometimes called a buy-sell agreement. Continue reading and contact a skilled Rochester business lawyer to learn about why this legal document is so essential and what can happen if your business doesn’t have one in place. Here are some of the questions you may have:

What is a Shareholders’ Agreement?

A shareholders’ agreement is a legally binding document that outlines the rights and obligations of the shareholders within a corporation. At its core, it serves as a roadmap for how owners will be governed in the business and how certain key decisions, including transition of ownership interest in the corporation, will be made.

The shareholders’ agreement details how shares can be transferred, how disputes between shareholders will be resolved, and how voting rights are allocated. Having these specifics written down can help avoid potential conflicts down the road.

Without a shareholders’ agreement, businesses are left to navigate difficult and complex situations without a clear process in place. This could lead to disputes that not only harm relationships but also impact the business’s success.

How Does a Shareholders’ Agreement Protect Business Owners?

In any business with multiple shareholders, there is always the potential for disagreements or unexpected changes. Whether a shareholder wants to sell their shares or perhaps one becomes incapacitated, a shareholders’ agreement can protect the business from the chaos that can be caused from unplanned ownership changes.

For example, what happens if one shareholder wants to sell their stake in the corporation? Without a clear process outlined, this could lead to disruptive issues that affect the business. A shareholders’ agreement can establish a clear process for how shares can be sold, including the granting of a right of first refusal, limitations on transfers, options to purchase or “put” shares. The agreement can provide what the purchase price of shares in the corporation are worth, how any buyout can be funded, and the circumstances of a buyout. By setting these terms in advance, rash decisions or costly disputes can be avoided.

The agreement can also protect minority shareholders. Without it, those with less ownership might find themselves limited to only rights protecting them under the business corporation law. A shareholders’ agreement can ensure their interests are protected by clearly outlining voting rights, access to information, and even compensation policies.

What Happens If You Don’t Have One?

Some businesses might believe that drafting a shareholders’ agreement is unnecessary. However, not having one in place can leave a company vulnerable. Without a shareholders’ agreement, a shareholder’s interest is generally governed by New York State’s Corporation Law, which may not reflect the specific needs or desires of the shareholders.

The absence of an agreement could lead to disputes over share transfers, control of the business or transition of the business. If conflicts arise, the lack of a predetermined process means the issue might have to be resolved through costly litigation or lengthy negotiations. Furthermore, if a shareholder unexpectedly wishes to exit the business and wants to sell their shares or unexpectedly dies or becomes incapacitated, the remaining owners may be left scrambling to keep things afloat.

By drafting this agreement, you are preparing solutions for potential problems that may arise. This provides peace of mind, not only for the shareholders themselves but for the corporation as a whole. It creates stability and helps to minimize risks associated with unforeseen changes. In the event your business structure is a limited liability company instead of a corporation, an operating agreement and/or buy-sell, can achieve similar benefits for members of a company that a shareholders’ agreement does for shareholders of a corporation.

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